As borrowing in dollars becomes increasingly expensive, the appetite for bonds in indigenous denominations in Africa is strengthening across the sub-Saharan region. However, longer yield curves and cross-border issuance will be necessary for continuing growth.

Africas growing local currency debt markets

Africa’s local currency debt capital markets are on the rise. Across the continent, ongoing regulatory reforms have unleashed a more powerful constituency of institutional investors just as currencies in the region have collapsed in value against the dollar, driving up the cost of non-locally denominated borrowing. Together, these trends have accelerated the growth of sub-Saharan African capital markets in a profound way, with local currency debt markets now on the path to becoming deeper and more diversified. 

This progress marks an encouraging departure from the historical norm. “In previous years, local currency debt markets across sub-Saharan Africa were very shallow. Any debt issuance that did occur was usually dominated by government transactions. In the past 18 months, however, we have seen a dramatic change,” says Megan McDonald, global head of debt primary markets with South Africa’s Standard Bank. 

This change has come as African sovereigns are feeling the strain from a sustained period of dollar-denominated Eurobond transactions. Buoyed by strong commodity prices and loose monetary policy in the developed world, total issuance jumped from about $1bn at the end of 2011 to $6.2bn by the end of 2014, according to Deutsche Bank. Indeed, despite collapsing commodity prices and an increase in US interest rates in 2015, a number of late transactions last year pushed total issuance above $6bn. 

Yet, financing this debt is going to become increasingly costly. “Over the past few years, sub-Saharan African sovereigns have enjoyed unusually favourable financing conditions. [But] the tide has turned – these sovereigns will direct an increasing share of revenues over the next three years to servicing their debt,” says Benjamin Young, a primary credit analyst with ratings agency Standard & Poor’s.

Local investors

The growing cost of dollar-denominated funding is providing further impetus to the development of local currency bond markets across the region. In Nigeria, the dollar borrowing market has become almost prohibitively expensive for local corporates, as the country grapples with a depreciating naira and the impact of foreign exchange controls. This situation has emerged as the authorities in Abuja have instigated a number of regulatory reforms aimed at promoting the growth of an institutional investor base in the country.

“In recent times there has been a gradual loosening of the regulatory restrictions on what pension funds are allowed to purchase. This has provided more opportunity to buy into corporate debt. It has also lowered the credit rating at which this debt can be bought. These changes have led to the emergence of a bigger and more liquid corporate bond market in naira,” says James Nelson, head of debt capital markets at Standard Chartered.

Nigerian pension funds’ assets under management have grown by about 25% per year since 2005, amounting to about $26bn in total managed funds by the end of 2014, according to Asoko Insight, a data provider on sub-Saharan Africa. Standard Bank’s Ms McDonald says an increasing number of Nigerian corporates, as well as local municipal authorities and states, are now issuing local currency bonds.

In particular, Nigerian banks have been quick to tap the local bond market over the past year, with United Bank for Africa, Stanbic IBTC and First City Monument Bank, among others, all issuing naira-denominated bonds in an effort to meet more stringent capital requirements. “[In general,] financial institutions are a good fit for raising local currency debt. Much of their existing exposure is to local currency, while they have a pool of assets that can be used to secure the transaction,” says Chris Low, group managing director of Letshego, a financial services group with a presence across sub-Saharan Africa.

Kenyan activity

Elsewhere on the continent, similar forces are shaping the growth of deeper and more liquid local currency bond markets. In Kenya, the first tranche of East African Breweries' Ks11bn ($107m) debt-raising programme was massively oversubscribed in the second quarter of 2015. With a target of Ks5bn, subscriptions quickly reached more than Ks9bn. This successful issuance followed the termination of its Ks5.4bn debut commercial paper.

“Kenya is probably the next biggest local currency market but both the number of investors as well as the total assets under management are considerably smaller than Nigeria. But we have certainly seen the emergence of corporate issuance in local currency for many of the same reasons,” says Mr Nelson. 

The growth of local currency bond markets has failed to attract the attention of international investors, however. According to Mr Nelson, this lack of interest is a product of risk appetite, with few investors willing to assume both credit and foreign exchange risk on a single investment. This means that while regional corporate debt can be attractive when denominated in dollars, the overall proposition diminishes when structured in local currency.

Cross-border borrowing

For Africa’s larger institutional investors, the investment focus remains in their country of origin. Nevertheless, with various programmes of regional integration afoot, particularly in west and east Africa, it might not be long before issuing and investing in local currency debt becomes both easier and more attractive across borders. 

“Institutional investors across the continent are showing growing interest in regional opportunities. In east Africa, moves are afoot to create a more level playing field in terms of issuing and investing in local currency bonds across borders,” says Ms McDonald.

For both regional and international banks, developments in the local currency bond markets offer sizeable long-term growth opportunities. For one, while dollar-denominated Eurobonds enjoyed a bumper year in 2015, with seven different sovereigns tapping the market, the outlook for 2016 is less clear. Accompanying this uncertainty, growing competition among both international and regional banks for a share of the market is making this space an increasingly difficult place in which to operate.  

As such, lenders with a large footprint across Africa and long-standing corporate relationships are looking to benefit from the growth of local capital markets. “For Standard Bank, we can capitalise on this trend because we have a presence in many of the key economies across the region. We are already lending in local currency to many corporate entities, so moving this partnership to the capital markets represents a natural evolution of that relationship,” says Ms McDonald. 

Equally, Standard Chartered’s Mr Nelson expects his bank to enjoy robust growth in the local currency bond markets. “Although we have the ability to facilitate both dollar and local currency funding, we have to determine where the most liquidity is at any one time. While dollar markets look increasingly fractious for the continent’s corporates, alternative currencies and markets are growing in importance,” he says.

Limitations remain 

Nevertheless, while the growth momentum in Africa’s local currency bond markets is accelerating, there is still a long way to go. Various challenges remain, including a lack of corporates with the size and sophistication to tap the capital markets. In many cases, securing bilateral financing through a banking partner is typically less onerous than completing a debut bond issuance. 

Moreover, the relative immaturity of these debt markets means that the creation of longer bond curves is also needed outside larger jurisdictions such as Nigeria. In Rwanda, for example, the government curve is five years, limiting the options available to the country’s corporate entities.

“We believe that in order for Africa’s economic growth to be sustainable it cannot be fuelled by foreign currency debt alone. In all of these markets the parallel development of a local currency debt market is of paramount importance,” says Ms McDonald.

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